The Weeklies

Recently, a great thing happened for options traders.  On a select few securities, options that expire on a weekly basis were introduced for trading.  Why is this great?  Because now you can lock in profits and limit losses on a more frequent basis.

One of the benefits of trading the weeklies is that the time decay is extremely fast.  Because these options only live for a week, they lose value (all else held the same) very quickly.  When you hear something like that, the first thing you should think of as a trader is that you can make a nice profit by selling options.  The tough part about this, though, is that because these options expire weekly, there range of strike prices is not as wide as it would be for the monthly options.

This means that if your strategy is to sell high probability, relatively low risk/return trades, you may have a tough time figuring out a good strategy.  At Intigril, I prefer selling credit spreads on the weekly SPY for the following reasons:

• The SPY is an ETF of the S&P 500, which tends to have lower volatility than individual stocks
• Because of the lower volatility, it’s easier to determine a range that the SPY will trade in
• It’s relatively easy to find strike prices that will result in a profitable trade 80+% of the time

My strategy is to sell credit spreads that are at least two strike prices out of the money.  The legs of the spreads themselves are about two to three strike prices apart.  This allows for a good return on invested capital with far fewer options that would need to be sold to achieve the same profit if the legs were one strike price apart.

Example

Let’s take an example.

The March Week 1 options just expired on Friday.  On Monday, the SPY was trading at 133.02.  At that point, I was able to sell a bull put credit spread at 130/128 for a total credit of 12 cents.  This may not sound like much, but if you sell a few hundred options on it, you can make a decent profit.

Now, this looks like a fairly safe trade, and in fact, if you calculated the probability of having a profitable trade, you’d see that it was over 90% at the time.  Now, let’s take a look at what happened throughout the rest of the week.

• On Tuesday, SPY tumbled to 130.92.  The price of the credit spread skyrocketed, and the paper loss that would appear in an account would be huge.  Keep in mind, though, that the spread is still well out of the money.
• On Wednesday, SPY rose a bit to 131.16.  The price of the spread at this time is still showing a large paper loss.  The average trader might be kicking himself for getting into this trade, and then decide to exit at a loss.
• On Thursday, SPY rose to 133.48, and at this point, the spread is almost completely worthless.
• On Friday, SPY closed at 132.47 and the options expired worthless

Hopefully you can see how wild a ride you would have been taken on if you had been in the spread the entire time.  You go from a 12 cent paper profit to an 80 cent paper loss to a 70 cent paper loss to a near 12 cent guaranteed gain.  Had you panicked at any point during that time, you would have walked away with far less than you could have earned.  In fact, you may have even taken a huge loss and destroyed your account.

What can we learn from this?

Trading discipline and psychology

The first thing to learn from this is that you should always have a plan for entering and exiting a trade before you get into a trade.  If you weren’t prepared to go on such a volatile ride, then you should never have been in that trade in the first place, or you should have timed it differently (or reduced your exposure by selling fewer options).

However, once you got into a trade, it’s crucially important to have the discipline and nerves of steel required to stick by your plan.  I actually entered this trade myself, and my exit strategy was to stay in unless the SPY went below 129.5.  It was a wild ride, but the probabilities of the original trade combined with my observation of the SPY and the general market made me confident that I would come out profitable.  Had I panicked and gotten out of the trade early, I would have experienced a loss.

Traders always say that it’s important to cut your losses and let your profits rise.  That’s true, but these traders usually work primarily with stocks and forex.  Options are a bit of a different beast.  When you sell options, you can make profits two ways:

1. You can wait until expiration to realize the full gain
2. You can sell early for a profit

Sometimes, in order to accomplish the former, you have to ride through the tough times.  I’m not saying don’t have an exit strategy in place, or don’t use a stop loss, or don’t cut your losses short.  This particular situation is probably unique to options credit spreads.  What I’m saying is that you do need to have steely resolve and control your emotions so that you don’t sabotage yourself.

Trading options is a business of discipline, probabilities, planning, analyzing, and constant monitoring.  The less you involve your emotions, the more profitable you’ll be.

Final words

The weeklies provide a great way to drastically increase your profit as a trader.  What you’ll need to do is plan your entry and exit points, both by day of week as well as by price, and come up with a good trading plan that you can follow.  Because these options have such rapid time decay, it may make sense to place trades on the Friday or Monday prior to their expiration.  And finally, when you trade credit spreads, remember to manage your risk and don’t get greedy.

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